Joint-venture structures, while common, are rising in popularity among real estate investors as an attractive route into new markets and sectors, as well as a way for existing owners, developers and operators to diversify risk, create new relationships and retain assets under management.
Joint-venture structures were primarily used for new developments and acquisitions but are now routinely employed for asset and portfolio recapitalizations.
While there are many kinds of joint ventures, one of the most common involves a general partner and one or more limited partners. The general partner is typically the operator, developer or manager of the venture while the limited partner is, most often, a relatively passive capital source. The general partner is responsible for managing the assets of the venture and executing the agreed-upon business plan.
While the limited partner(s) provide most of the required equity capital, most general partners provide a meaningful amount of co-investment capital alongside the limited partner(s), allowing for an alignment of interests among all parties. The general partner is compensated via fees (acquisition, asset management, development management, etc.) and a disproportionate share of the profits for successfully executing the venture’s business plan.
Joint-venture agreements are most commonly structured as limited liability companies or limited partnerships. Details of the venture agreement include a focus on the business plan goals and objectives, financial commitments, how profits will be split, management responsibilities, ownership rights and exit mechanism. Financial investment structures can range from a 50/50 venture all the way to 90/10 or 95/5 in terms of co-investment and ownership interest.
Virtually every type of capital source including pensions funds, endowments, sovereign wealth funds, insurance companies and family offices, to list a few, are active investors as limited partners in joint ventures. Overseas investors, in particular, stand to benefit in multiple ways by investing in the U.S. with partners via joint ventures.
For example, sovereign wealth funds and certain qualified pension funds that are subject to Internal Revenue Service Rule 892 enjoy significant tax savings when making U.S. real estate investments via minority ownership positions in joint-venture partnerships. (According to a November 2011 tax alert from law firm Akin Gump, Rule 892 “exempts from U.S. income taxation certain investment income from stocks, bonds and other securities derived by a foreign government, where a ‘foreign government’ is defined as an integral part of a foreign sovereign, or a Controlled Entity.”)
More recently, the pandemic, with its travel limitations, has provided more incentive to deploy capital in overseas real estate via joint-venture partnerships. Capital is seeking high-quality and reliable operating partners with a local presence to help find and manage investment opportunities in an environment where representatives of the capital partner may not be as free to spend time in the markets where the best investment opportunities are available.
Additionally, some countries, such as Israel, have regulations in place preventing certain types of investors, such as insurance companies, from owning more than 50% of an overseas asset.
An emerging trend in the industry is recapitalizations of assets, portfolios or sometimes entire funds. For example, when a closed-end fund comes to the end of its life, the fund sponsor is forced to sell the asset(s) per the original fund structure. However, increasingly, the fund sponsor can recapitalize the asset or portfolio of assets via a joint-venture partnership with a capital source that is interested in owning the assets long term.
Such a recapitalization in lieu of an outright sale offers the operating partner an opportunity to repay its current fund investors while continuing to own and manage these assets. The incoming capital partner’s capital may be better aligned with the risk profile of the investment going forward, both in terms of the cost of capital and investment horizon.
Of course, joint-venture strategies are not without challenges. If entering into a joint venture, make sure to have like-minded partners in terms of risk tolerance, investment horizon and business plan. There needs to be a meeting of the minds on the investment thesis, including the hold period/exit mechanism and how major decisions will be made. The terms get much more complex as the number of stakeholders increases.
While joint-venture acquisition volume in the U.S. is pervasive across all property types, office accounted for most joint ventures entered into in 2020, according to JLL data.
Also, according to JLL data, between 35% and 40% of transactions above $100 million in Europe, the Middle East and Africa are already in some form of joint venture.
Globally, 27% of investors plan to increase their allocations to joint ventures, according to an INREV survey. Just 4% said they expected to decrease their use of the strategy. INREV also notes that roughly 45% of European investors are expected to increase their allocations to joint ventures through 2022.
There is a real opportunity for owners and managers to capitalize on strong ongoing demand as investors continue to see the benefits of using joint ventures to enter new markets, gain direct access to assets and align themselves with specialized management expertise.
Riaz Cassum is JLL’s executive managing director, capital markets and global head – international capital coverage.